U.S. Fed closing the door on low-rate mortgages in Canada

The U.S. Federal Reserve raised its trend-setting interest rate on Wednesday for the third time in six months to the highest level since the global financial crisis hit in the fall of 2008.

The Fed’s latest show of faith in the strengthening U.S. economy comes as Bank of Canada governor Stephen Poloz suggests “the interest rate cuts we did two years ago have done their job.”

Simply put, taking on a mortgage is about to become more expensive on both sides of the border, even if Poloz’s hint that a Canadian a rate hike is on the horizon turns out to be unfounded.

“Interest rates are rising in the U.S. and it doesn’t take long for that to filter into Canada,” mortgage broker Ian Macfadyen told CTV News. “Ultra-low (mortgages) are probably, for the most part, over.”

As the saying goes, when the U.S. sneezes, Canada gets a cold. U.S. interest rates and the impact on Canadian mortgages are no exception.

Fixed-rate mortgages, the most common in Canada, are tied to long-term Canadian bond prices, which are in turn tied to U.S. bond prices. Banks sell bonds to raise money to lend to mortgage holders and other borrowers. When the U.S. Federal Reserve raises rates, bond prices typically fall. As bond prices fall, banks tighten their lending, and mortgage rates rise.

For example: if current interest rates rise, giving newly-issued bonds a yield of 10 per cent, older issues yielding 5 per cent would not be in demand until their price falls to match the same return generated by the new prevailing interest rate.

The prospect of a pricier mortgage is a major talking point for prospective buyers like Eric Samure. The 28-year-old chartered accountant said he has been saving to buy a home in Ottawa for more than two years, and will have to weigh some tough choices if borrowing becomes more costly.

“You could bite the bullet and buy a place you can’t afford, or you can just save up longer. I’m taking the approach to save up longer so it’s affordable,” he said.

Macfadyen predicts the era of cheap money is drawing to a close. He suggests the rates on offer today are as good as they are going to get for the next several years.

“The message should be if you are getting a mortgage to go fixed,” he said. “If you are going to refinance, roll in as much of your debt into a lower fixed rate, otherwise you will be susceptible to rises in interest rates.”

Many economists are predicting the Bank of Canada will hike its overnight lending rate for the first time in nearly seven years by the end of 2017.

David Rosenberg, the chief economist at Gluskin Sheff + Associates, is in that camp. He believes Canada’s economy has moved past two of the bank’s justifications for keeping rates at record lows.

“They brought in two emergency rate cuts totaling 50 basis points in 2015 to deal with an energy price shock. You know that is behind us,” he said. “And an Alberta recession, that is in the rear view mirror.”

Rosenberg said Poloz has surprised the markets with rate moves in the past, and could start raising Canada’s key lending rate as soon as July.

“The question you have to ask yourself is why now he is starting to talk more openly about the possibility of taking back two rate cuts that we don’t need anymore,” he said. “Why wouldn’t he move in July?”

That looming decision, and the rate hike south of the border, has Samure and his partner thinking about how to scale back their dream home. But two years of careful saving have only strengthened their resolve to enter the housing market the moment they can afford it.

“It’s going to go up just a little bit now, maybe in six months it’s going to go up even more,” he said. “You can predict how much you save, but you can’t predict the outcome.”